Busch: Home Prices — Bad News, Good Signs

Today, S&P Case-Schiller released their October composite 20 city index that showed a drop of 18%. The price index peaked in July of 2006 at 206.52 and now stands at 158.16, a stunning 23.4% decline. So far for 2008, the index has declined from 180.69 to 158.16 or 12.4% this year.

Back at the beginning of 2008, I predicted that the housing market would stabilize in the fall with existing home sales bottoming around 5 million per month. Prior to Lehman, this occurred EHS fell to a low of 4.85 million a month and had gone sideways since March. September sales actually had the best month of the year at 5.14 million, and the monthly inventories were falling as well with foreclosure sales accounting for the majority of the sales. Then credit for mortgages evaporated. EHS fell to 4.91 million in October and then cratered to 4.49 million in November.

We've also seen a dramatic drop in housing starts and building permits....but this is what is needed to stabilize the housing market. The inventory of unsold new homes has fallen to 372k from a peak of 570k in June of 2006. It's clear that the lack of building is having a dramatic impact on the supply on the market and this will eventually support prices.

Unfortunately, new homes are only one-fifth of the housing market. The inventory of unsold existing homes continues to have an oversupply that stands at over 11 months. This needs to drop to around 6 months to normalize. However, the drop in building of new homes means that buyers have to go to existing homes to satisfy their demand. If yearly household formation is around twice the level of housing starts, then demand will outstrip supply enough to raise existing home sales.

This doesn't mean that it will happen smoothly. Yes, mortgage applications have jumped significantly with the sharp drop in interest rates. The problem is threefold: lack of non-conforming loans, higher required credit scores, and lower required LTV ratios. So while borrowers want loans, banks are making them more expensive and less available. This is hampering the recovery process. Another negative is rising unemployment.

However, the U.S. Federal Reserve buying MBS to force down mortgage rates is helping reduce the cost to borrowers. A program to supply mortgages at 4.5% from the incoming Obama administration would help as well. Clearly, there are a lot of moving parts to the housing story in the United States. The best news is that under-building is having the desired effect on the market and soon it will expand further.